Homeownership: How could the tax incentives be improved?

Two kinds of changes could improve the tax incentives for homeownership. The first would redirect the tax subsidies from higher-income households to those with lower incomes to focus assistance on those most in need. The second would simply reduce existing incentives.

Replacing the existing deductions for mortgage interest and property taxes with a tax credit would shift homeowner subsidies down the income distribution to households more in need. For example, replacing those deductions with a credit of up to $1,400 for property taxes paid on a primary residence would shift more than 40 percent of the subsidy from households in the top income quintile to other households, with no change in federal revenue (see table). About half of the benefits thus shifted would go to households in the bottom two-fifths of the income distribution.

Making the credit refundable would increase the share of benefits going to households with the lowest incomes.

The deduction for mortgage interest is currently limited to the interest on no more than $1 million of mortgage debt. Lowering that limit to $400,000 would increase federal revenue by $30 billion between 2008 and 2012 and nearly $60 billion more over the subsequent five years. Virtually all of the impact of lowering the limit would fall on households at the top of the income distribution. Congress could use the additional revenue to pay for direct subsidies to facilitate homeownership by lower-income households. The change would disproportionately affect households in high-cost housing markets, where prices for a large share of houses could require purchasers to take out large mortgages.